Francesca's Sell-Off Is Warranted As Comparable Store Sales Have Imploded

Shares of Francesca's Holdings (NASDAQ:FRAN) sold off following the release of its first quarter results for its fiscal year of 2013.

Yet this latest sell-off does not automatically translate into a buying opportunity. While same store sales growth is expected to recover in the second half of the year, and there are growth opportunities ahead, I remain on the sidelines. A fairly high valuation and concerns about competition eating into Francesca's fat profit margins are among my key concerns.

First Quarter Results

Francesca's generated first quarter revenues of $79.0 million, up 29% on the previous year. Revenues just missed consensus estimates of $79.6 million.

Net income rose by 25% to $10.9 million as earnings per share rose by four cents to $0.24 per diluted share. Adjusted earnings per share came in two cents higher and were exactly in line with consensus estimates. CEO Neill Davis commented on the first quarter developments:

We delivered on our earnings expectations as well as several strategic goals in the first quarter. We opened 56 new boutiques increasing our market presence to 416 boutiques, achieved record direct-to-consumer sales now representing 2.1% of total Company sales for the quarter, and successfully completed the rollout of our new point-of-sale system in our boutiques.

Looking Into The Results...

Revenue growth was primarily driven by new store openings. Francesca's opened 56 new boutique stores during the quarter explaining the majority of revenue growth as comparable sales rose a mere 2%. Last year, comparable sales rose a much more impressive 16%.

Direct-to-consumer sales nearly doubled, increasing by 97%, thanks to higher traffic, conversion and average spending. Excluding direct-to-consumer sales, comparable sales were flat, badly missing the outlook for a 4 to 5% increase. The company is partially blaming unseasonable weather for the miss.

Gross margins fell 70 basis points to 52.4% on the back of higher promotions during the quarter. Disappointing as well was the 40 basis point increase in selling, general and administrative expenses which came in at 28.8% of total sales on the back of more store openings and infrastructure investments for its e-commerce website.

... And The Second Quarter Outlook

Francesca's sees its second quarter revenues coming in between $94.5 and $95.5 million. This assumes a 1-2% increase in comparable sales, including direct-to-consumer sales, and the opening of 21 new stores. As such revenues are expected to increase by 24% on the year.

Earnings per share are expected to come in between $0.35 and $0.36 per share, up 21 to 24% on last year's adjusted earnings.

Full year sales are expected to come in between $365 and $370 million, assuming a 4-5% increase in comparable sales and 85 boutiques openings. Adjusted earnings per share are expected to come in between $1.27 and $1.30, up 22 to 25% on the year. The full year earning guidance came in a bit soft compared to consensus estimates of $1.30 per share.

Valuation

Francesca's ended its first quarter with $33.8 million in cash and equivalents. The company operates without any debt, for a solid net cash position allowing the firm to continue to open new stores.

Factoring in the 9% drop following the earnings release, shares are exchanging hands around $27.50 per share, valuing the firm at $1.20 billion. This values operates assets at $1.17 billion which values the firm at 3.2 times this year's expected annual revenues and roughly 20 times annual earnings.

Francesca's does not pay a dividend at the moment.

Some Historical Perspective

Back in the summer of 2011, Francesca sold its shares to the general public at $17 per share in a $170 million public offering. Shares quickly rose to levels in the mid-twenties to fall to lows in their mid-teens at the end of the year. From that point shares rallied all the way to $35 in August of last year trade in a $25-$30 trading range ever since.

Between 2009 and 2012, revenues have almost quadrupled to $296.4 million over the past year. Earnings growth was even more impressive as net earnings came in at $47.1 million over the past year.

Investment Thesis

Investors are obviously disappointed with the massive slowdown in comparable store sales, as comparable growth in brick-and-mortar stores has come to a complete standstill. Obviously the reported rate of 2% came in below both the company's own expectations as well as those from Wall Street.

While difficult comparisons and poor weather are real factors impacting the reported growth rates, I must conclude the general performance of the company seems a bit soft as well. After opening 56 stores in the first quarter, the company guides for full year openings of 85 new stores, up from 80 planned openings earlier.

Lower comparable store sales growth rates implies that opening new stores becomes increasingly more important to boost total revenue growth.

A bright spot is the updated website from the company which has driven direct-to-consumer sales which doubled over the year. While the relative pace of store openings is slowing down, as the store base continues to expand, Francesca's will end the year with roughly 445 stores which is roughly half its long term target of 900 US stores.

While the long term potential remains, and the company expects that same store sales growth will accelerate into the second half of the year, I remain on the sidelines. After the sell-off shares are still valued at 20 times this year's expected earnings.

This valuation might seem fair to some given the growth prospects, but I am a little concerned about the long term prospects for margins. At the moment the company already earns fourteen cents after tax on each dollar of revenue. I would suspect that competition results in lower margins in the long end.

I remain on the sidelines on the back of a fairly high valuation, despite prospects of continued growth, as I fear an increase in competition.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.